PRS: a reliable income

It’s bigger, faster and – with mayor Sadiq Khan’s new 35% affordable housing threshold – could work for renters as well as landlords. Graham Shone reveals why PRS is on the cusp of delivering long-term, stable returns that could see both domestic and foreign investors flocking If ever there were a time to invest in the private rental sector, now might just be it. A window of opportunity fuelled by unprecedented market conditions and demographic changes means the PRS model in both the capital and the wider UK is on the cusp of becoming a linchpin for helping create sufficient diversity in the housing sector. All optimal conditions which should, in turn, see the PRS market deliver long-term stable returns for an ever-growing plethora of investors. But why now? What exactly are these unprecedented market conditions? And can we put a figure on just how far the sector has grown? New-builds on the rise It all starts in the capital where, in pure numerical terms, trends in new-build residential property have been unprecedented over the past few years. Never before has the construction of new private units outstripped the construction of social units to such a wild extent. In 2015, construction started on 21,171 more private units than social – a gap that has grown by a staggering 1,400% since 2010, when just 1,410 more private starts took place. Beyond that, there are currently 123,200 more private units than social units at the permission stage waiting to get under way. And that gap has grown by 118% since 2010 – meaning that with the current bank of stock in London, the gap between private and social construction starts is likely to continue to grow in the immediate term. What this has precipitated is a market wherein home ownership becomes too costly for a greater number of Londoners – priced out by the ever-accelerating top-end of the residential market pulling average prices skyward. This subsequently means they are finding it increasingly difficult to claw themselves onto the decreasing pool of affordable units at the bottom end. Rip in the fabric The peak of London home ownership, according to the government’s English Housing Survey, was in 2005-2006, when 1.83m households were owner-occupied. Since then, there has been a 10% drop in such households in the capital. Over the same time span, private rental households have increased by 78%, from 504,000 to 898,000 households. That increase has created a situation where renters outnumber those who own their homes. Just over 50% of households in London are now renter-occupied, with 27.2% of those in the private rental market – a growth from 16% in 2006, and far outstripping the rest of England (see graph, below). So, the trends are clear. The “rip in the fabric” of London residential development in the traditional sense has opened up the door for a foray into build-to-rent schemes for a wider pool of developers. London is a city with an increasing propensity to rent – and whether that is as a result of affordability, or simply a generational change in attitudes towards ownership, there has never been a more active demand for rental properties. “Local councils are beginning to come round to the benefits of a thriving build-to-rent market” The final piece of the puzzle on PRS becoming a genuine asset class, and thereby boosting its influence over London development, lies within its burgeoning appeal to institutional investors. In recent years, we have seen initial forays into the sector from Legal & General and M&G Real Estate, among others. The appeal to these bodies is in the long-term, stable returns that the sector can offer. Once upon a time, that particular niche was the proviso of the retail real estate sector. However, with lease lengths decreasing year by year on those properties (now at eight years on average, down from 8.7 in 2014), and with the threat of floorspace reduction, the security that was once almost assured with retail investments is becoming much scarcer. Similarly, government bonds – another favoured income stream for institutional bodies – are not producing the rates of return they once did. So, piling money and resources into genuine place-making through vast private rental developments which gradually generate a solid return has, understandably, grown in appeal. Of course, there’s no such thing as a sure thing, but given the aforementioned market conditions of London residential – added to the insatiable, and growing, demand from 20- to 30-somethings for high-quality residential spaces – one would expect this growth to continue. The new political reality The private rental sector is wholly different from traditional private residential development in several ways, but one of the most significant differences is in how it gets delivered – and how quickly. Private units have accelerated away from affordable in recent years – with London’s new mayor, Sadiq Khan, already taking measures to ensure that affordable housing is not left behind. He has introduced a flat-rate of 35% affordable units for new residential projects to adhere to – which, while helping somewhat to alleviate the affordability issue, may prove problematic, given the issues around financial viability for developments that require affordable units. For those developments, it is often mentioned that the potential gross development value against the land and construction costs does not yield sufficient profit for a private developer to consider the project viable. With that in mind, there is likely to be a fall in the overall number of for-sale units delivered while developers reassess how best to adapt to the new political realities. PRS schemes, however, may be almost immune to such issues, given they will look to make the returns over longer periods of time, rather than looking exclusively at GDV. Given that PRS developers will want their premises let and providing maximum returns as quickly as possible, the traditional phasing method by which private units are delivered will not occur. Schemes totalling hundreds of PRS units are more likely to go up at once, and complete within a shorter time frame, helping to boost overall supply both during and after the readjustment to the 35% rate. Behavioural shifts Khan is pushing ahead with plans to close that expanding gap between private and social new-build stock. As a result, that gap is what precipitated the market conditions wherein PRS has been able to thrive, so naturally this raises the question of what might happen to this sector if those conditions no longer exist. Legislative and behavioural changes hold the key. Legislative changes to give increased rights to tenants over longer lease terms would benefit landlords looking to keep income streams solid for a number of years, as well as giving increased security to occupiers. Ironically enough, this would constitute a leaning towards more of a European rental model while the UK as a whole negotiates its divorce from the European Union. Similarly, with such an emphasis on placemaking being at the heart of a successful PRS scheme, local councils are beginning to come round to the benefits of a thriving build-to-rent market. The regenerative quality that a long-term investment product would have on a local area would be profound – with highest possible quality public realm, landscaping and commercial offer tied into the residential product. If developers are committed to these schemes for the long haul, those regenerative qualities will last much longer than they perhaps would with a block of units that is simply sold, and then moved on from. Behavioural changes go along with the legislative changes – essentially consisting of a shift away from the desire to own property, and managing the debt that goes along with that, towards a desire to “rent for life” under new tenant-friendly legislation, in a dwelling that is possibly a grade above what a tenant could afford via a mortgage. Such a behavioural shift won’t be quick, but the rise in appeal of top-end student accommodation indicates a beginning of new generations preparing for a PRS future. The PRS pipeline As the map below indicates, this is a pan-London phenomenon, with only a few areas seeing little to no activity. Several of the major projects have sprung up on the eastern edge of Zone 2, reflecting the demographic to which these PRS developments are hoping to appeal. These are located relatively close to the centre of London, and a commutable distance away from most of London’s workplace hubs. Areas such as Elephant and Castle, Lewisham, and Stratford have a multitude of large-scale PRS projects, indicating the groundswell of developer intent in those locations – all of which have undergone huge changes already in recent years. Croydon, unsurprisingly, appears as a hotspot, thanks largely to PDR developments such as Delta Point and St Anne’s House – both of which are 100-plus unit projects marked for PRS. EGi London Residential Research has split its analysis between the inner and outer boroughs – 66% of the total units are in outer locations, but with a great many located extremely close to what LRR would describe as inner.   How EGI London Residential Research measures the rise in PRS Our method of research on residential development in London is: when a housing project goes in for planning, we track it through construction until it completes, and sells. PRS throws a spanner into these particular works as it’s often harder to ascertain when exactly a development “becomes” PRS. Some sites are, of course, purchased with the expressed intent to develop for the residential private rental sector – those are relatively straightforward “full-PRS” schemes. Others we monitor become wholly or partially PRS at various points within their development cycle: some during construction, some before construction, some during the planning procedure – and others even after they have completed, but prior to the sales launch. Therefore, to ably track the rise of PRS in London, one needs to identify a “PRS date” – a point in time at which a certain number of units within a scheme can be identified as being developed for the private rental sector. Those dates (grouped by year) and units are shown (see charts, above) – indicating what the market has been talking about for some time. Nearly 14,000 new-build units were marked for PRS during 2015 across 104 projects – an almost a threefold increase on 2014. These units are split into three via three colour codes, as can also be seen on the map opposite. The main bracket are those that have been 100% confirmed by the developer via planning documents, a sales launch or otherwise as being for the private rental market. These are either at permission, under construction, or completed. The other large section shows possible rental units – largely comprised of schemes at the application or pre-application stage that we have not yet recorded as rental units (but will be marked as such if/when permission is obtained). Also within this are existing projects wherein some units have been tentatively mentioned as being flipped to PRS from traditional private sale – but no complete confirmation as yet. The third section covers schemes marked as PRS, but which are office conversions via permitted development. All of these schemes total 30,359 units marked for the private rental market, with 19,904 of those (66%) coming since the start of 2015.